2012 (10) TMI 721 - HC - Income Tax

Direction for special audit - Deemed dividend u/s 2(22)(e) - advances received from one of its partners with no interest was paid - Held that - There is a good deal of force in the contention of the petitioner that there was no proposal initially by the AO for special audit and that he did not form any opinion that the accounts of the assessee were complex and a special audit was required to protect the interests of the revenue. AO did examine the accounts of the assessee on 18.11.2011. He issued a proposal for special audit under Section 142(2A) on 21.11.2011. The petitioner submitted a detailed reply to the same on 24.11.2011. After considering the reply, the AO prepared a report on 16.12.2011. The penultimate paragraph to this report gives the impression that it was some kind of an interim report, informing the CIT that the submissions of the petitioner are being examined with regard to the issues raised in the show cause notice, the CBDT guidelines, the provisions of law and the judicial decisions relied upon. It also states that the issue of business advance received by the assessee from DLF Ltd. and in turn advanced to certain land owning companies was being examined in the assessment proceedings. AO further stated in the final report that whatever details are required in respect of the issues raised in the show cause notice dated 21.11.2011 were being examined in the assessment proceedings and the assessee has been asked to furnish further details (which is an apparent reference to the hearing posted on 28.11.2011) and further that a draft order has been prepared which is enclosed with the final report for the perusal of the CIT. It is very difficult to treat this report of the Assessing Officer as a proposal submitted by him to the CIT for special audit of the accounts of the petitioner. Also it contains a clear statement that since the complexities in the accounts have been answered by the petitioner and since the details and material submitted by the petitioner would be examined in the course of the assessment proceedings which were pending on that date, no special audit was required. It difficult to accede to the proposition that the CCIT could have applied his mind in such a short period of time to the proposal put forward by the Assessing Officer on 27.12.2011 as both the proposal and the approval bear the same date. In these circumstances, there could not have been a serious application of mind on the part of the CCIT. It was merely a ritualistic or mechanical approval given by the CCIT. There is nothing on record to show that there was any fresh development between 26th December and 27th December, 2011 compelling the AO to change his mind and come to the conclusion that certain complexities have been noted in the accounts of the assessee and therefore special audit was required to be carried out. It was incumbent on the AO to issue another show-cause notice to the petitioner u/s 142 (2A), after he changed his mind and proposed special audit on 27.12.2011, and invite the petitioner s objections - in favour of assessee.

Issues Involved:
1. Validity of the show cause notice under Section 142(2A) of the Income Tax Act.
2. Complexity of the accounts of the petitioner.
3. Compliance with the principles of natural justice.
4. Application of mind by the Chief Commissioner of Income Tax (CCIT) before approving the special audit.
5. Impact of procedural and substantive lapses on the validity of the special audit order.

Issue-wise Detailed Analysis:

1. Validity of the show cause notice under Section 142(2A) of the Income Tax Act:
The petitioner, a partnership firm engaged in construction and real estate, filed a return declaring a loss. The Assessing Officer (AO) issued a show cause notice proposing a special audit under Section 142(2A) due to complexities observed in the accounts. The petitioner objected, arguing that similar issues had been resolved in their favor in previous assessments, and that the AO had not raised any queries during the test-check of books, implying no complexity.

2. Complexity of the accounts of the petitioner:
The AO identified four complexities:
(a) Business advances from a partner with no interest paid, potentially avoiding deemed dividend provisions.
(b) Payments for development rights shown as "stock" without sufficient details.
(c) Lack of details for a deduction claimed under "reimbursement of expenses."
(d) No revenue recognition on sale consideration, contrary to the stated accounting policy.

The petitioner countered these points by providing explanations and documents, asserting that the same accounting methods were consistently followed and previously accepted by appellate authorities.

3. Compliance with the principles of natural justice:
The petitioner argued that the AO did not provide a reasonable opportunity to contest the need for a special audit, as required by the proviso to Section 142(2A). The AO continued assessment proceedings without raising further queries, indicating no complexity. The court noted that the special audit entails civil consequences, and the principles of natural justice require the AO to genuinely attempt to understand the accounts and seek explanations before deeming them complex.

4. Application of mind by the Chief Commissioner of Income Tax (CCIT) before approving the special audit:
The court examined the sequence of events and communications between the AO, CIT, and CCIT. It found that the AO initially concluded no special audit was necessary, but changed his opinion overnight without new developments or compelling reasons. The CCIT's approval appeared mechanical and lacked serious application of mind, as it was given on the same day the proposal was received.

5. Impact of procedural and substantive lapses on the validity of the special audit order:
The court concluded that the AO's change of opinion lacked justification and procedural fairness. The absence of a fresh show cause notice after the change of opinion and the lack of CCIT's proper application of mind rendered the special audit order invalid. Consequently, the court quashed the direction for a special audit and all subsequent proceedings.

Conclusion:
The writ petition was allowed, quashing the orders for special audit due to procedural lapses, lack of proper application of mind, and failure to comply with principles of natural justice.

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